Fitch Ratings has affirmed Indian Railway Finance Corporation Limited's (IRFC) Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDR) at 'BBB-'.

The Outlook is Stable, in line with that of the Indian sovereign (BBB-/Stable). Fitch has also affirmed IRFC's USD7 billion global medium-term note programme and outstanding senior unsecured note rating at 'BBB-'.

The affirmation reflects Fitch's view that IRFC remains an important Indian government-related entity (GRE). We have taken into consideration the company's strategic role in supporting India's railway sector and a robust framework for state support. Hence, Fitch believes that the government has a very strong incentive to provide extraordinary support to IRFC, if needed. The state-owned IRFC is a non-banking financial company that acts as the dedicated lending arm of the Ministry of Railways (MoR).

KEY RATING DRIVERS

Status, Ownership and Control: 'Very Strong'

We have factored in our expectations that the government will maintain a majority stake and control of IRFC. The state owned 86.36% of IRFC in the fiscal year end-March 2022 (FY22) and exercised control via the company's boards, which include two government nominees. Under IRFC's annual standard lease agreement, the MoR is required to redeem the company's maturing bonds or term loans in the event the company is unable to repay. The MoR also signs an annual memorandum of understanding (MoU) with IRFC that governs borrowing targets and financing levels.

Support Track Record: 'Very Strong'

Fitch believes that government support for IRFC's policy role is evident from the government's framework to ensure IRFC's financial viability, including preventing liquidity mismatches, and a cost-plus model. The framework and model are included in the standard lease agreement. The agreement allows the MoR to make advance payments to IRFC to ensure the company has sufficient resources to repay debt, although IRFC has never used the provision to meet debt-servicing requirements. In addition, IRFC's leases to the MoR are based on a weighted-average cost plus a margin.

Socio-Political Implications of Default: 'Strong'

Fitch's assessment reflects IRFC's policy role in financing Indian Railways (IR), a statutory body under the MoR that operates the national railway system. Fitch believes that IRFC's importance as a MoR financing vehicle remains the same despite the company's contribution to IR's budget falling to about 31% in FY22 from 67% in FY21. The extraordinary contribution in FY21 was due mainly to supporting the economic recovery during the Covid-19 pandemic. Fitch believes IRFC's contribution to railway capital outlay will increase gradually along with the increasing capex trend for the railway sector.

Hence, a default would probably disrupt IR's ability to finance the capital expansion, which is a strategic area of the country's economic plan. Fitch also believes IRFC's policy role may be difficult to be substituted in light of the close ties between the company's operations and that of the MoR.

Financial Implications of Default: 'Very Strong'

We believe market participants regard IRFC as the state's proxy funding vehicle for the sector. The alignment of the cost of borrowing with that of the national government underpins our assessment. IRFC is the MoR's dedicated lending arm, with over 98% of the company's leasing assets loaned to IR as of end-December 2022. Therefore, a default by IRFC could imply a failure of the MoR in honouring the obligations under the standard lease agreement. This may have material implications for the credibility of the government and the financing for other state-owned GREs.

Operating Performance

IRFC will gradually increase its contribution to the government's infrastructure investment plan over the long term, in Fitch's view. The MoU governs IRFC's borrowing and loan disbursement, which are closely tied to the MoR's capital outlay plan. IRFC's interest income rose by 85% to INR73 billion in FY22 and lease income by 10% to INR130 billion. Furthermore, interest income increase by 3% year-on-year (yoy) in 9MFY23 to INR55 billion and lease income by 35% yoy to INR121 billion.

Derivation Summary

Fitch has assessed IRFC under the Government-Related Entities Rating Criteria, factoring in the company's strength of linkage with the government, and the government's incentive to support, with a high overall support score of 50. This results in the equalisation of IRFC's IDR with that of the Indian sovereign irrespective of the company's standalone credit profile.

Liquidity and Debt Structure

IRFC's rapid expansion in the past few years resulted in a gradual increase in the net gearing ratio, net debt/equity, to 9.47x by FYE22 (FYE21: 9.0x). IRFC has adequate asset and liability management, which is subject to guidelines set by the central bank. Fitch believes government support and the company's diversified funding sources should mitigate potential refinancing risks.

Issuer Profile

IRFC is a non-banking financial company majority owned by the Indian state, which acts as the dedicated lending arm of the MoR. The company finances the acquisition of rolling stock assets, leasing of railway infrastructure assets, and lending to other entities under the MoR.

Rating Sensitivities

Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade

A downgrade of the Indian sovereign rating.

Material dilution in the government's shareholding.

Material dilution in the government's support.

A weakening in the support score to below 45.

Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade

Any positive movement or upgrade in the Indian sovereign rating would be reflected in IRFC's ratings.

Any rating action on IRFC's IDRs would result in a similar action on the rating of its senior unsecured notes.

ESG Considerations

Fitch does not assign ESG scores for IRFC as the ratings and ESG profile are derived from the parent, India. ESG relevance scores and commentary for the parent entity can be found here.

Public Ratings with Credit Linkage to other ratings

IRFC's IDR is credit-linked to India's sovereign IDR.

Best/Worst Case Rating Scenario

International scale credit ratings of Sovereigns, Public Finance and Infrastructure issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of three notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

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